Is a drop in unemployment a good or a bad thing for investors?
Last week, the US weekly jobless claims dropped to a near 49 year low (a seasonally adjusted jobless claim of 207,000, as per CBNC) and the unemployment rate for September declined to 3.7%.
GREAT NEWS? Well, it depends on who you ask. If you ask the average person on Main Street, he/she would say absolutely.
But if you ask a person on Bay Street or Wall Street they would say NO WAY.
Why the difference in response?
The US and Canada (to lesser extent) are close to full employment and central banks are concerned that full employment brings higher wage demands, and eventually higher inflation. If this occurs, central banks increase interest rates to cool the economy and control inflation.
As the cost of borrowing increases, borrowers reduce discretionary spending to cover the higher borrowing costs AND fewer people qualify for loans given the higher interest rates. Eventually, this cools the economy and sometimes leads to a recession.
Main Street loves the current economy because it means more jobs and higher wages, but Bay Street fears this economy because it leads to higher interest rates, a possible recession and lower corporate profits.
The Dri Financial Group has planned for this scenario for many years.
The following is our strategy:
- We invested one, two- and three-year cash flow requirements (i.e. for RRIF payments) in guaranteed investments, which are unaffected by the market volatility.
- We increased the bond component to approximately 20-40% of the portfolios, note that bonds historically increase in value during market declines thus offsetting stock declines.
- Our Smart Fixed Income Model which alternates between stocks and cash (depending on the strength of the market) has been in the safety of cash since September 4th. This represents approximately 5-10% of the portfolios.
- The equity component is invested in blue chip companies that pay a dividend and can increase their dividend annually. Historically, dividend growth stocks have been safer harbours during recessions.
- Finally, should we enter a much longer recession (like 2007-09), we will sell a percentage of stocks and purchase certain ETFs that increase in value as the markets decline.
For some clients, this may be their first market correction so, it’s important to set realistic expectations. Let’s assume that Client A has an asset allocation of 60% equities and 40% cash, bonds, preferred shares and GICs and the Canadian S&P/TSX index falls by 15% (which is completely normal), client A should be prepared for a decline of approximately 9%.
Allow me to be more direct, a $1,000,000 portfolio will decline by approximately $90,000 (again, this would be totally normal). But remember that markets corrections don’t last forever. According to Yardeni Research, there has been 36, S&P 500 corrections (declines of +10%) since 1950 and the average length has been approximately 196 calendar days.
In summary, we have set aside short-term money, we’ve taken asset allocation precautions, we’ve invested in dividend growth stocks and most importantly, market corrections don’t last forever.
If you would like to discuss investment strategies or need help with planning, call me or email me at richard.dri@scotiawealth.com.